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The 'carried interest' debate

Mitt Romney may have vanished from the political scene, but his former industry — the world of private equity and high finance — hasn’t.

President Barack Obama and some Democratic tax writers are signaling that they want to renew their fight to raise taxes on the "carried interest" income paid to managers of private equity firms, hedge funds and many Wall Street powerhouses.

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It may seem like an easy sell: because their earnings are classified as capital gains, these titans of finance pay a top tax rate of 20 percent on the money they make, less than many middle-class taxpayers.

But the political dynamics of carried interest aren’t so simple, and they routinely put Democrats with moneyed constituents or donors on Wall Street — see: Chuck Schumer — in an awkward spot.

Carried interest is a foot in the door to a broader — and even more complicated — issue of reforming the entire tax code.

But it could come up sooner than that, with President Barack Obama gunning to replace the sequester with a mix of tax hikes and spending cuts, as he advocated in a Tuesday announcement at the White House — and in an interview before last weekend’s Super Bowl.

The private equity industry says it’s being unfairly singled out — and is on guard.

Here are five questions on all things carried interest.

What is carried interest?

It sounds complicated, but it’s easier to grasp than you might think.

At its most basic level, carried interest is a term for the profits-based compensation paid to investment managers. These are the people who run private equity firms, hedge funds, venture capital groups and some real estate firms.

With Romney, the former CEO of Bain Capital, headlining the GOP presidential ticket last year, carried interest was most often associated with private equity managers.

So let’s take that example.

Private equity firms are almost always formed as partnerships. The partners make an investment in the firm and the firm, in turn, invests in and often restructures companies. If that investment turns a profit — and that profit exceeds the partners’ initial investment and other investors are paid a pre-arranged fee — then the partner is paid in the form of carried interest.

Here’s where the tax policy debate comes in: for decades, carried interest income has been tied to capital gains for tax purposes. That means that today, carried interest income is taxed at a 20 percent rate. That compares to a 39.6 percent top rate on so-called ordinary income like wages.

Why am I always hearing about this — even in Obama’s pre-Super Bowl interview?

Carried interest is a favorite target for Obama and the Democrats in Congress.

Every budget produced by the Obama administration hits on the issue.

And remember that whole tax fairness theme that Obama ran on last year? At least in theory, carried interest plays right into that.